Wednesday, July 9, 2014

Much has been made of the “dots”, the pretty smattering of
the FOMC voting members depicting their Fed Fund expectations to 2016 and then
for the “Long Run” thereafter. The
tabling of these expectations are potent as they show the FOMC voters true thoughts
no matter the verbiage of the Minutes or the Statement prior. A voting FOMC member can now dissent anonymously
without casting a dissenting vote, providing subtle and yet more powerful
contrary views. Finally, in the “Long
Run” Fed Funds expectations, the Keynesian steeped FOMC members – no matter if a classic Taylor like
view or a New Keynesian “forward guidance” believer – all agree Fed Funds converge to
NGDP. So much can be expressed in the ‘Dots”
without knocking heads against Chairman Yellen directly, or entering into a
weary argument, once again, with the likes of President Kocherlakota or Secretary English. The “true believers” are onto this form of
sneaky dissension and have even started a move to ban the “Dots” forcing dissenters into a publically noticed “no”
vote. But for now we still have the ‘Dots”. It is obvious the "1%" expectation FOMC voter does not believe in a single word of both the Minutes and the prior Statement.

The “Dots” as almost all wrestle with to date are here:

Very pretty indeed, and then most cut and paste several of these FOMC charts on top of each other, holding
them up to a bright light, to get an idea how they change.

A better way to consider the “Dots” is via the famous
statistician John Tukey's “box plot”, with each column above represented by a “box
and whisker”. The line bisecting the box
(sometimes it doesn't bisect if the expectations are extremely skewed) is the
median value, the top and bottom of the box is the 75th and 25th
quartile boundary and the dotted line goes out to the 100% but for extreme trimmed outliers which are
shown well above or below the box. Those
are our “secret dissenters”. A set of boxplots are plotted for the Dec 2013,
Mar 2014 and the June 2014 FOMC package attached to the minutes. And here it is:

A lot easier to track the “secret dissenters” and the range
of the calls and the median of those calls which most see as the “Fed Funds “
path as if it is written on a tablet from the mountain. There is obviously much turmoil at the FOMC
hiding behind the tepid minutes written by the “true believer” Secretary Bill
English to suit the Chair’s supposedly all-encompassing view. To my read it looks like the FOMC consensus
is now a facade of sorts and there are some serious mischief makers armed with
their large credible staffers back at the regional FRB office tower. Then there are some technical issues of note –
first extreme disconnect for the majority of the FOMC who feel a very large 1%
rise in the Fed Funds will be required – hopefully not all on the last day of
2015 as the Chairman suggests. Then the majority believe another wrenching very
large 1.5% add on to Fed Funds are required in 2016. Given the size of these expectations of the
FOMC majority, and taking into account past FOMC tightening, most of this 2.5%
raise will happen swiftly, likely within 6 months or even shorter. The next interesting point is that the Long
Run consensus is very tight around 3 ¾%, but that has dropped from 4%
recently. This shows the entire FOMC is
a believer in the “New Normal” of Bill Gross, just not as much a drop that he
anticipates from the “Normal” long run NGDP.
And a significant change in this belief to even a more pessimistic view occurred
in the three months between March 2014 and June 2014. Why? Yet
at the same time the expectations for growth or return to trend growth
accelerated from the March FOMC meeting to the June, as shown by increases by
the majority of FOMC voting members for 2015 and 2016. No wonder the curve flattened so much in 1st Q
to 2nd Q 2014. The dispersion increased in the June meeting for both 2015
and 2016, suggesting greatly increased volatility is implicitly expected by the
FOMC voting members. VIX shorts should take note.

This shows the basis point vol as reflected in the dispersion of the FOMC voters:

The move from 0.78 yield vol to 1.26 for 2016 Fed Fund call in the June FOMC will likely result in about a 2% 2 year vol at some point which will be wrenching and perhaps transmit to a 25% VIX and 2 year SP vol swap.

The voting members of the FOMC “Dots” should be taken in very
carefully with a few caveats. The first, though with exceptional knowledge,
experience and insight, is that these are human expectations and the wide differences between the members shows clearly the lack of consensus, despite the unanimous vote. And
those expectations, already diverse, always change with a “whoosh”. The second point, on that “whoosh”, is well
described by Mike Tyson; “everyone has a plan until they are punched in the
face”.

Or
to paraphrase; “Expectations from the FOMC are reliable until they change, suddenly.”

The “Dots” should also be seen as the tip of an iceberg
where each “dot” is backed by a army of researchers and the credentialed, who are
without a doubt the best in the world at monetary policy and monetary economics.
Each “dot” represents thousands of hours of research and debate,
sometimes intense debate to the point careers are ruined, or then rescued as
Kehoe was at the Minneapolis FRB. So
each “dot” is the end results of the very complex political demands of each
voter to their home base, and is a melding of their staffers views and their own. At the very least the voter is
required to spend hours upon hours consulting and interacting with the staffers
even if the voter's personal view is different.
That is unless you are President Kocherlakota in which case you simply
fire the bastards.

Followers

About Me

Many years of experience in being a market maker, a trader, a salesguy or portfolio manager in almost all asset classes known. Have had a high teens average career return and yet can say that I have lost more money in more asset classes than anyone I know.
My biggest curse is that not even wishing to become involved: "I see dead people.", as the kid said in the movie. I can smell a trade in the drawer or financial fraud or PL blowup miles away. Should have been with the FBI if wanted to max social utility.
Autodidact in all things math, formal education in history.